Batten Down the Hatches

That term is a nautical term from the early 19th century. The captain of the ship would order sailors to "batten down the hatches" to avoid taking on water when heading into a severe storm. Energy investors should be taking steps to keep their portfolios from taking on water in the months ahead.

All signs are pointing to lower oil prices in the months ahead and energy equities are already showing the strain. The long awaited flurry of M&A in the sector has failed to appear and companies are having trouble selling non-core assets to raise money.

Pioneer Resources is trying to sell 640,000 acres in the Niobrara field in northern Colorado and they only expect to get $200 an acre. That is well below the high prices paid when the shale boom began.

Energy XXI has been trying to sell some non-core assets in the Gulf of Mexico for several months now with no takers. About the only thing moving in the M&A market is pipelines and infrastructure.

Hess sold half of its Bakken midstream assets to Global Infrastructure Partners for $2.68 billion. The joint venture plans to file for a MLP IPO upon the closing of the transaction. There have been several acquisitions announced in the pipeline sector because these are expensive to build, easy to unload and the seller normally agrees to ship a specific amount of product through the pipeline in the decade to follow. The producer gets their money back from building the asset and the buyer gets to charge a fee forever for every barrel shipped.

The challenge for the sector is the outlook for crude production. The EIA actually raised 2015 production estimates by 240,000 bpd despite the 60% decline in active rigs. Crude production rose to 9.61 mbpd last week and only slightly below the 9.637 mbpd peak from 1970. For analysts looking for lower production and higher prices the scenario is just not working out.

Saudi Arabia is trying to contract with India for additional oil exports that will see Saudi pump more than the record 10.3 mbpd it pumped in May. Saudi Arabia, Kuwait and the UAE are all racing to drill more wells with Saudi operating a record number of rigs today.

This is going to be a nightmare for U.S. producers. Active rigs are likely to continue falling. Analysts had expected to see a rebound in July but that is now off the table. Active rigs have now fallen for 27 consecutive weeks.

Oil prices have returned to resistance at $61 because of the rise in gasoline prices headed into the July 4th weekend. This is the peak driving weekend before demand begins to slow for the rest of the summer. Once gasoline demand slows the price of oil should weaken.

Some analysts believe we will see WTI back below $50 later this year. With those expectations looking more realistic as each day passes the potential for additional capex cuts in the drilling sector are very likely.

BP put out their Statistical Review of World Energy 2015 and they claim the global energy picture has undergone a "tectonic shift" since 2014. They believe we will always look back at 2014 as a pivotal moment in energy.

They point out that oil demand has been very anemic with an increase of only 0.9% in 2014 with most of that from China. Other analysts believe demand increased only 500-600,000 bpd in 2014 despite the drop in prices. However, the IEA recently increased their expectations for 2015 to an increase of +1.4 mbpd. Historically lower oil prices for an extended period increased demand significantly and that demand remained solid in the years that followed. Saudi Arabia said they expect that to happen again if prices remain low.

It is those low prices that are going to cause trouble. Eventually companies are going to run out of locations where they can produce cheap oil and drilling will slow until production declines enough to push prices higher. This is a very long cycle that could take several years. In the end the laws of supply and demand will return to balance and prices will find a reasonable value.

Oil Inventories

Crude inventories declined -6.8 million barrels to 470.6 million.

Refinery utilization rose from 93.2% last week to 94.6%. Imports fell -750,000 bpd. U.S. production rose another +24,000 barrels to 9.61 mbpd.

In the graphic below green represents a recent high and yellow a recent low.

Active Rigs

Active drilling rigs declined -9 to 859 for the week ended on Friday. This was the 27th consecutive week of declines. Oil rigs declined -7 for the week to 635. Active gas rigs fell -1 to 221. Active rigs have now declined -1,072 since the high of 1,931 in September. That is a -60% drop. Active offshore rigs rose +2 to 29 and well off their January high of 60.